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Budgeting Basics 3: Setting Category Limits© Sound Mind Investing | March 2009
In Budgeting Basics 2: Tracking Your Spending, we focused on tracking your spending and knowing exactly where your money is going. This is of critical importance in establishing a workable budget. Hopefully you have recorded your transactions over the past several weeks, and have gained some insight into your current spending habits. The next step is to establish limits for each spending category. Begin by converting your transaction amounts to percentages so you can see what proportion of your spending each category currently represents. Here's an example: If you spent $250 on recreation and your monthly net spendable income (the amount left over after your tithe and taxes have been paid) is $3,337, your recreation category used up 7.5% of your budget last month (250/3337 = .075). Take a moment to translate your spending in each category (including savings and investments) into a percentage, then add them all up. When you're done, the total should equal 100% of your net spendable income. To make sense of these percentages, you need a frame of reference. So, listed in the table below are the percentage guidelines taken from Crown's Family Financial Workbook. These guidelines are what Crown Financial Ministries recommends for a married couple with two children.  You will likely find that your target percentages vary from these somewhat, based on your income level, family situation, and so forth. However, huge discrepancies between your percentages and theirs could be a warning sign. Crown's guidelines can help you identify potential problem areas with your current spending. In the beginning of our marriage, Kim and I didn't realize that more than 10% of our income was going to the recreation category (eating out can be a real budget buster). Tracking our income and expenditures showed us what was happening. We also learned that more than 25% of our income was going toward our debt category. We didn't want to reduce this number, however, because we were focusing on getting debt-free. But to have such a high percentage going to the debt category, we had to make sacrifices and adjustments in others. We lived in an apartment at the time, so our housing category was only 15%. Our bargain-shopper tendencies allowed our food and clothes categories to be just 8.5% and 1.5%, respectively. And although we would have preferred to save more, our savings rate was only 2.2%. We were okay with these various tradeoffs because we: (1) knew where our money had been going, (2) had a plan for where it would be going from now on, and (3) were making progress toward our financial goal of paying off our debts. MAKING IT PERSONALAs you compare each guideline percentage to your current spending percentage, ask the Lord to show you where and how your categories should be adjusted. Some areas (such as insurance) may not leave much wiggle room. But other areas, such as food, clothes, recreation, and the catch-all miscellaneous category usually can be adjusted. Develop your own table showing each category, the dollar amount you've been spending, and what that amount translates into as a percentage of your total net spendable income. Now, add two more columns, with headings of "My Dollar Goal" and "My Percentage Goal." Go through each category, and identify areas where you think you can reduce your spending. Fill in your "dollar goal" amount for each one. For example, if you've been spending $210 a month on clothing and think you could reasonably cut that to $180, write that down in the "dollar goal" column on the clothing line. Make a note off to the side that you now have $30 you can apply elsewhere. Repeat this step with each category that can be lowered. Next, deal with the categories that need extra money allocated to them. Use the funds from the reductions you made earlier to adjust these categories as need be. Don't be discouraged if you need to go through this cutting/re-allocating process several times. To see how your new budget compares to Crown's percentage guidelines, take your new dollar goal amount for each category and divide it by your net spendable income. In our earlier example, we changed our goal amount for clothing to $180, giving us a new "percentage goal" of 5.4% (180/3337 = .054). Hopefully, your new percentages will match up more closely with Crown's recommendations. VARIABLE INCOME AND EXPENSESCategories that vary from month to month, such as utilities, are usually best handled by budgeting an average of the past 12 months (assuming you have the numbers available). Add up your past 12 bills and divide by 12. Also, if you have expenses that are paid just once per year (life insurance premiums, Christmas, vacation), it's a good idea to build a monthly amount into your budget. Save that money each month in a separate account so it's available when needed. What about income that varies, such as a salary that's paid on commission? Again, the best way would be to take an average of a complete cycle (usually a full year). Pay particular attention to any busy seasons you might have. In other words, if you have a commission job and have just come through your busy season (meaning your recent paychecks have been higher), calculating an average based only on your recent numbers isn't wise. Err on the side of caution. It's always best to budget based on conservative numbers. Next month, we'll deal with implementing your new budget percentages. This month's process may seem painful, but you'll find it gets easier as you get used to living with a spending plan. Furthermore, disciplined spending is quite liberating and rewarding — contrary to what our materialistic culture would lead you to believe. As 1 Corinthians 3:19 reminds us, "the wisdom of this world is foolishness in God's sight."
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